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Dr D. Subbarao, Governor of the Reserve Bank of India (RBI), is in a Catch-22 situation. If he doesn't raise interest rates, he stands accused of doing nothing to tame inflation. But if he does raise interest rates, his ability to control inflation, as the general public sees it, is rather limited. As can be seen from the graph below, the increase in interest rates by RBI hasn't necessarily resulted in an easing of inflation in past few years in India.

The Wholesale Price Inflation for September 2011 stood at 9.72 per cent. Fuel and Food, which together comprise 22 per cent of this index, have been a major reason for the increase. Fuel and Power inflation increased to 14.09 per cent, due to Rs 3.14-rise in the price of petrol on September 1, 2011. Food inflation was at 10.6 per cent in the week ending October 8, as against 9.32 per cent in the week before that, providing no relief to the aam admi.

Interestingly, food forms nearly 14 per cent of the Wholesale Price Index, and increasing the interest rates simply isn't the solution to controlling the food prices. There are several reasons for this.

Higher rural income
First and foremost, rural India is eating better. This is primarily because of a surge in rural income. As analyst Akhilesh Tilotia of Kotak Institutional Equities points out in a report titled ‘This Time is Ripe', the total income in rural India has gone up by 138 per cent to Rs 6,81,400 crore during a five-year period ending in 2009.
It need not be said this is primarily because of the Mahatma Gandhi National Rural Employment Guarantee Scheme, which has led to a significant flow of money into rural India.

Over and above this, the United Progressive Alliance is getting for the next Lok Sabha elections with the introduction of the Food Security Bill. The Bill is currently up for discussion and draft guarantees food to priority households i.e. those below the poverty line, as well as other poor families who have been classified as ‘general households'. This move if and when it goes through is expected to drive food prices up all over the world, because of the sheer numbers (population) that we have.

There are other problems as well which will continue to drive food prices up in the years to come. A report brought out by DWS Investments suggests that “dramatic increases in the irrigation of crops across northern India have substantially depleted the region's groundwater. This would mean lesser water for irrigation across the Gangetic plain which produces a major part of the grain that India consumes.”

Grain and food production is also threatened by other long-term factors. One is the continued expansion of some of our biggest cities at the cost of taking over agriculture land. As environmentalist Mr Lester Brown writes in Outgrowing the Earth: The Food Security Challenge in an Age of Falling Water Tables and Rising Temperatures, “As a country industrialises and modernises, crop land is used for industrial and residential development.Secondly, as rapid industrialisation pulls labour out of the countryside, it often leads to less double cropping.”

Shrinking acreage
In fact the world is running out of land for agriculture. The world renowned hedge fund manager Mr Jeremy Grantham explains this in his newsletter titled Time to Wake Up: Days of Abundant Resources and Falling Prices Are Over Forever, “Only Brazil, and perhaps the Ukraine, has really large potential increments of output. Elsewhere, available land is shrinking. We have, though, had impressive productivity gains per acre in the past, and this has indeed helped a lot. But, sadly, these gains are decreasing.”

What also does not help is the prospect of higher atmospheric temperature.

Crop ecologists use a rule of thumb that for each 1-degree-Celsius rise in temperature above the optimum during the growing season, we can expect a 10-per cent decline in grain yields.”

As Brown points out “In India, the giant Gangotri Glacier, which helps keep the Ganges river flowing during the dry season, is retreating. The Ganges is, by far the largest source of surface water irrigation in India.”

Many of the above factors are already translating into almost doubling the Price of Food Index, Dhaanya, at NCDEX, the leading agricultural commodities exchange in the country.

The factors are way beyond the control of Mr Subbarao and he cannot do anything about it by increasing interest rates. So, will his interest rate hikes bring down the inflation rates? We doubt!

Monday, October 10, 2011

Mr. N J Yasaswy, NJY for most of us, passed away on Saturday October 8th, 2011. The founder of ICFAI, was of 62 years.

I had gone on my honeymoon to Srinagar. On our way from Srinagar to Pehalgaon, on a foggy chilly morning, we stopped for tea amidst the mountains. Just next to the tea shop, there was a small office with a board, IFEN (ICFAI Flexi Education). I laughed. And then marveled at the reach and penetration of ICFAI.

True to the vision of NJY, ICFAI reached, touched and penetrated into every conceivable market for Business education in India. I recall NJY telling us in one of the meetings, “Everyone is entitled to education. Isn’t an average student entitled to higher education in the Business domain? Does one have to crack the CAT and be the top 2,000-3,000 in a country where almost 10 lakh graduates want to pursue an MBA every year?” These were not merely words; he actually made a Business education possible for everyone. From 2 years full time MBA, to part-time and distance MBA, to executive MBA, he offered them all under the ICFAI umbrella. He has left behind an empire of 11 ICFAI Universities, 8 Icfai Business Schools, and many more Icfai National Colleges.

I joined ICFAI in 2002 as a Doctoral student. Just a week into the program, before meeting the man himself, accounts of his brilliance reached my years. I was told that he was the all India 1st rank holder for CA, CS and ICWA. And that the ICAI still kept his answer scripts as model answer scripts on their website. Well I never checked it myself. But, I did not need to. Whether he was the 1st rank holder in all three (CA, CS and ICWA) or not and whether ICAI kept his answer scripts as model papers or not, the man was a genius. Being a teacher, I am used to talk more and listen less. But when he spoke, everyone listened. Including me. Out of Respect and Awe. Not Fear.

I had the opportunity to interact with him on numerous occasions. Over the years, I happened to be in various committees and would meet with him in the review meetings very frequently. He used to take a lot of pride in the smallest of achievements of any of the ICFAI constituents. His eyes would twinkle as he would tell us about the Icfai cases appearing in many foreign author books, or ICMR making money through adsense, or ICFAI Tripura being a threat to the local Universities in North East. He had Big Dreams for ICFAI.

Last year when I was leaving IBS Hyderabad, I had met him and chatted with him for more than an hour. I was a bit skeptical at first. I was nervous that he might get angry, or he might not understand my reason for leaving. But I was so very wrong. He was extremely happy for me. He told me that I am doing the right thing. He told me that it was important for me to go outside the Icfai system and prove myself and that I was taking a good decision in concentrating my efforts on research, which also gave me the flexibility to focus on my family. His consent and his approval of my decision meant the world to me. He told me that I was welcome to rejoin IBS after my stint at ISB. For any employee, this would be the greatest compliment, that she is welcome back in the same organization. And NJY, the founder of ICFAI, himself gave me that compliment.

The man is no more. But he has touched the lives of lakhs of people, Icfai alumini, faculty, staff, prospective students and the Indian corporates. We are all grateful to him for his vision and his creation. May his soul rest in peace.

Wednesday, October 5, 2011

The last quarter (July-September) has seen most of the economic indicators going for a roller coaster ride in India. In September, Interest Rate was increased yet another time and the Oil Marketing Companies increased the Oil prices once again. Inflation has touched newer heights and the Index of Industrial Output (IIP) plunged to a 21 month low in July. The rupee has been plummeting on average and the stock market indices have been volatile to say the least.
IIP growth decelerated sharply to 3.3% in July 2011 from 8.8% in June 2011, and from 9.9% in July 2010. The uncertainties in policymaking and the increasing loss of credibility of the UPA government are causing many companies to defer their investment and expansion plans. The IIP compiled in India has in its scope the Mining, Manufacturing and Electricity sectors. The increasing dependence of the government on debt leaves no doubt in the minds of the companies that the government will not be able to spend on infrastructure and give boost to the economy if need be.
Increasing the interest rates makes borrowings more expensive for the companies and individuals. Hence they postpone or cancel their expansion plans. This results in depleted producer sentiments and reduced capital spending. This in turn results in a further lower IIP.

Owing to high costs of borrowing, a few companies might resort to layoffs or pay-cuts, leaving individuals with lower disposable income. Also, higher interests on deposits might lure individuals to save now and consume later. Both, lower disposable income and higher savings, results in lower consumption, leading to lower sales and profits, lower production, lower IIP, hence, lower stock prices. Looming threat of the US and European nations going back into recession is not helping the situation. The exports to these nations are bound to be hit. While a falling rupee will benefit the exporters, the demand itself might drop.
The impact of an oil price increase on inflation cannot be ignored as well. It must be noted that increased oil prices directly result in an increase in inflation as it is a major component of the Consumer Price Index. It also results in increased airfares, shipping costs, public transport etc., thereby indirectly increasing the inflation further. By letting the OMCs increase the price of oil, the government is contributing to a further rise in inflation on one hand, and adding salt to the wounds of the common man by further increasing the interest rates to control the same inflation.

Mr. Pranab Mukherjee was quick to point out that petrol has been deregulated and it is the OMCs who have in their review decided to increase the price. True. But then, who reviews and makes the decisions for these companies? And who benefits from such decisions? It is clear from Table 1 that the Government being the majority shareholder in these companies, must be approving the price rises. Also, these companies distribute whopping amounts as dividends, not to mention the contribution to the exchequer in the form of taxes and duties (see table 1)!

Table 1:

Source: CMIE prowess database and Annual Reports of the companies

In the year 2010-2011, the amount of subsidies towards petroleum products doled out by the central government was Rs38,400 crores (source: union budget 2011-2012). A look at table shows that the OMCs together pay much more to the government in the form of taxes, duties and dividends.

Our central banker Mr. Subbarao claims that the rise in interest rates would curb inflation. Figure 1 clearly shows that increasing the interest rates have not been able to rein in the inflation in the past one year. So yet another rise in interest rate seems to be in vain.

Figure 1:

What seems to be the case is that the inflation in India is demand driven. So the need of the moment would be to ensure supply, increased productivity and efficiency rather that curbing the demand. Curbing the demand would not help in achieving the growth targets. It would push the country into a slow growth or recessionary phase. That would be a real shame, considering that we have one of the brightest economists and a man responsible for the India turnaround story as our current Prime Minister.
Source: RBI

Tuesday, October 4, 2011

These are interesting times for the Indian Stock Exchanges. We might see a new player in the stock exchanges arena soon, MCX-Stock Exchange (MCX-SX). Since long, MCX-SX's application has been pending with the Securities Exchange Board of India (SEBI) for a license to operate as a full- fledged stock exchange.

National Stock Exchange (NSE), since its inception in 1994, has revolutionized capital markets in India. Due to initiatives taken by NSE, the Indian markets are now more efficient. NSE has monopoly in the futures and options and wholesale debt markets and is the clear market leader in equities and gold ETF trading. This forced financial intermediaries to use technology which provides data feeds from NSE for all segments. On the other hand, BSE has more than 7,000 companies which are not listed on NSE, and hence traders were forced to separately work on BSE's online trading platform (BOLT).

Competition between exchanges

In addition, the Multi Commodity Exchange of India (MCX), market leader in commodity derivatives, provided its feed on software called ODIN, developed by its parent company (Financial Technologies). While intermediaries found it difficult to switch between softwares, they had no choice. These technological woes of the brokers seem to be ending as competition between the exchanges intensifies. While a monopoly does enjoy economies of scale, but competition is always good for the end users. The fear of losing a customer to a competitor propels the companies to innovate, serve and optimize.

Owing to a recent development, wherein the Bombay High Court advised the SEBI to settle its dispute with the MCX-SX regarding its ownership structure which is preventing SEBI from allowing it to become a full fledged stock exchange, in a move to combat the almost certain entry of MCX-SX in the equity and derivatives trading arena, arch rivals, NSE and Bombay Stock Exchange (BSE) are joining hands to provide their stock price feeds through a single trading platform.

In another development just two months back, the Competition Commission of India (CCI), armed with the new competition law which became fully enforceable in the month of June this year, slapped a fine of Rs 55 crore on NSE for waiving transaction charges and abusing its dominant position in the Currency Derivatives (CD) segment. NSE has now obtained a stay by the Competition Appellate Tribunal (Compat) on the penalty, but has ended its zero-pricing policy with effect from August 22nd, 2011. In the same order, the CCI had instructed NSE to share its application programme interface code (APIC) with ODIN users.

Also, Financial Technologies (FTL), the promoter company of MCX and MCX-SX, a global leader in providing exchange and trading technology platforms and solutions, launched DMA (Direct Market Access) live a couple of days back. DMA live will provide clients with greater control and direct access to their trades, reducing transaction costs, increasing speed and efficiency of transaction.

More exchanges

This is meant to benefit the financial institutions and brokers. On one hand the consolidation of exchanges continues, on the other hand new exchanges are successfully capturing market share. Key to their success is technology.

Researchers are still trying to find an answer to whether fragmentation is good or bad for the investors. Maureen O'Hara and Mao Ye in their research paper, “Is market fragmentation harming market quality?”, published in the Journal of Financial Economics in June 2011, find that “fragmentation affects all stocks; more fragmented stocks have lower transactions costs and faster execution speeds; and fragmentation is associated with higher short-term volatility but greater market efficiency, in that prices are closer to being a random walk”. Their results show that “fragmentation does not appear to harm market quality” and “are consistent with US markets being a single virtual market with multiple points of entry”. However, in the US there is the National Market System (NMS) linking all the different exchanges and investors can see prices of all the markets, compare and then choose the best.

MCX-SX, the potential new player in the exchange industry in India, with the backing of a global leader in exchange and trading technology (FTL), may change the game for the existing Indian players, NSE and BSE.